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A new client, a private trading company, has taken out fixed term life assurance policies on its directors who are also the shareholders. In the event of the death of a director, the company receives the policy proceeds. There are double option agreements between the company and directors, so that the company will then buy back the deceased director's shares from his estate at an agreed value equal to the policy proceeds. The conditions for this, being a capital distribution, are likely to be met.
A new client, a private trading company, has taken out fixed term life assurance policies on its directors who are also the shareholders. In the event of the death of a director, the company receives the policy proceeds. There are double option agreements between the company and directors, so that the company will then buy back the deceased director's shares from his estate at an agreed value equal to the policy proceeds. The conditions for this, being a capital distribution, are likely to be met.
The company has previously been told that if the monthly life assurance premiums are not taken as a corporation tax deduction then the proceeds will be tax free.
Is this correct, or would the proceeds be taxed as a chargeable gain with the monthly premiums treated as the capital cost? Are there any implications for the company or shareholder's estate because the agreed buyback value is unlikely to equal the value of the company at the time of the director's death?
(Query T15,993) - Perplexed.
The Inland Revenue's view on key man policies is generally that the sole purpose test is unlikely to be met where the directors are major shareholders. The reasoning is that the payment is not exclusively for the trade but partly to protect the shareholder's estate as is the case here. The premium will not be deductible. The Inland Revenue also follows the statement made public in Parliament in 1944. 'Normally' receipts are not taxed as trading income. However, there can be no guarantee that such receipts will not be taxed, but it seems that the receipts in this case are likely to be tax free since they are not being used to pay off a loan relationship or to fund ongoing trade.
As far as the company is concerned, we have a straightforward position but 'Perplexed' is worried about valuations. Provided we are looking at a company purchase of own shares, there should be no worries for capital gains. The company and the shareholders may be connected persons, but section 18, Taxation of Chargeable Gains Act 1992 can only apply where there is an acquisition of the asset. Since a company cannot own its own shares and the shares bought back are cancelled, there is no acquisition. Probate value should be the amount for which those shares can be sold so that there will be no gain for the estate.
Where we do have an issue is with business property relief. Business property relief is not available if there is a binding contract for sale of the shares (section 113, Inheritance Tax Act 1984). The Inland Revenue's views are clarified in Statement of Practice SP12/80. That states that, in the Inland Revenue's view, a buy and sell agreement is tantamount to a binding contract because it is more than an option. Put and call options are not a buy and sell agreement and business property relief should still be available but I have found that, where shares are to be sold back to the company rather than the other shareholders, the agreement is almost like a buy and sell arrangement.
The basic conundrum is that, the more protection there is, the tighter is the buy and sell agreement and so the risk of losing business property relief increases. The more there is a certainty of business property relief, the looser is the agreement and the less protection there is. Without sight of the agreements, I cannot give a definitive answer.
- JWG.
A Parliamentary statement in 1944 dealt with the subject of key man insurance in the following terms:
'I am, however, advised that the general practice in dealing with insurances by employers on the lives of employees is to treat the premiums as admissible deductions, and any sums received under a policy as trading receipts, if (i) the sole relationship is that of employer and employee; (ii) insurance is intended to meet loss of profit resulting from the loss of services of the employee; and (iii) it is an annual or short term insurance.'
It will be seen that this statement is very restrictive as regards cases where relief can be obtained for premiums paid. If the employee is a major shareholder or if the insurance is not short term, there seems little likelihood of getting relief for premiums paid.
As regards the proceeds of the policy, there is an exemption from capital gains tax for life policies in section 210, Taxation of Chargeable Gains Act 1992. However, this is not quite the end of the story and the tax treatment of the proceeds for corporation tax purposes need not have any relevance to the question of whether relief was obtained for the premiums. The answer depends on whether, as a matter of ordinary accounting, the proceeds are received as income or as a capital receipt. It will be recalled that in Commissioners of Inland Revenue v Falkirk Ice Rink Ltd 51 TC 42 a lump sum donation to a company was received as revenue and therefore made liable to corporation tax. However, given the link between the policy and the option arrangements for the proceeds to be used for the purchase of shares, it would seem strongly arguable that the proceeds do not accrue to the company as a revenue item and would not therefore be taxable. - Big Shot.
